Last week I pointed out that most borrowers don’t shop for title insurance, accepting the recommendations of their Realtor, lender or builder. Competition for business by title agencies is thus directed not at borrowers but at entities with referral power, which often results in kickbacks to referrers rather than lower prices or better service.
Kickbacks are illegal unless they have been sanitized by creation of an affiliated business arrangement (ABA) between a referrer and a title agency. ABAs make kickbacks legal but costly. The price of title insurance cannot be reduced by allowing kickbacks to be legalized at high cost, nor can it be reduced by suppressing illegal kickbacks.
The way to reduce the cost of title insurance (and also mortgage insurance and credit insurance) is to have the federal government mandate a general policy that any insurance that protects only lenders must be paid for by lenders. On any real estate transaction that involves a mortgage, lenders should pay the policy premium on the lender policy, plus related title costs.
Implications of Lender-Paid Title Insurance
If lenders had to pay for title insurance, prices would drop. Instead of millions of buyers a year taking one policy each, there would be thousands, each one purchasing many policies. The buyers would be knowledgeable rather than ignorant; they would be in the market continuously rather than once or twice; they would shop alternative sources rather than accept recommendations from interested parties; and they would have the clout associated with their purchase volume.
Of course, borrowers would pay for the lender policy in the price of the mortgage. The incremental price, however, would be a faction of what they pay now.
Lender Insurance Versus Borrower Insurance
On mortgage refinance transactions, lenders would pay for lender policies, and borrowers would have the option to buy or not to buy title policies that protect them. On home purchases in areas where home buyers purchase their own title insurance, they would have the same option. In both cases, borrowers would have to be persuaded that the incremental protection provided by owners’ policies are worth the price. This is as it should be.
In some areas, by law or custom, home sellers are obliged to purchase homeowner policies for the buyer. Lender policies are a “simultaneous issue,” often priced at a discount. Since home sellers, in selecting a title agency, will continue to be influenced by Realtors, instituting a lender-pay requirement on lender policies may not have much immediate impact on title costs. Hopefully, over time, the evidence of price declines elsewhere will generate pressures to eliminate the practice of having home sellers purchase title policies for buyers.
State Regulation a Partial Barrier
A potential impediment to price declines would be state regulation of title insurance premiums. Such regulation is supposed to protect consumers, which it doesn’t. In some states, it may provide the major title insurers with a convenient way to collude on premiums.
In Texas, New Mexico and Florida, the state actually sets the premiums. In some others, insurers are allowed to band together to propose premium rates that the state will then approve for all of them. In a third group, each company posts its own premium rates with the state; in some, the state must approve (“File and Use”), in others no approval is needed (“Use and File”). In all cases, the information is public and available to other insurers.
Resistance to declines in posted insurance premiums will be strong. The title insurance industry is highly concentrated at the insurer level, with the five largest companies writing about 90 percent of the policies. These companies also have a demonstrated ability to influence state legislatures.
Prices will drop nonetheless. Large lenders probably will negotiate package deals with the major insurers, who will be obliged to reduce their posted prices. Smaller lenders probably will negotiate deals with local agencies, which have cost structures swollen by high marketing expenses, including legal and illegal kickbacks. (On average, agencies retain more than 70 percent of all title insurance premiums). Large lenders could also deal with the agencies if the large insurers refuse to drop their posted prices.
The prospects for legislation that would require lenders to pay for their own title protection depend on the attitudes of the major groups that would be affected by it. This will be discussed next week.
The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.